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An one Euro coin is displayed on a Greek Drachma and Euro (R) banknotes in this picture illustration. (MURAD SEZER/REUTERS)
An one Euro coin is displayed on a Greek Drachma and Euro (R) banknotes in this picture illustration. (MURAD SEZER/REUTERS)

Why bank stress tests in Europe were abysmal Add to ...

If only Europe’s stress tests had been as rigorous as those in the U.S.

Practically the day after the American results were released in March 2009, the markets started a months-long massive rally. In Europe, not only has there been no such turnaround, but the test administrators had the chance to fix their errors in a second bout of testing, yet they made the same mistakes again.

Even though everyone and their mother knew the first round of tests were barely usable, last fall Franco-Belgian bank Dexia was on the precipice of collapse just two months it passed the supposedly intensive second round of tests.

Contrast that with what happened in the U.S. As the country’s financial system plummeting, administrators applied rigorous tests and released the results in early 2009. Soon after, the market went on a tear, and the banks promised to raise capital and sell off non-core assets to shore up their balance sheets.

What few people here in North America understand is the root of the difference between these two scenarios. It comes down to one fatal flaw: the Europeans didn’t assess how much capital was held against sovereign debt. Government bonds issued by countries like Greece were tagged risk-free, and the banks then had no reason to keep a piggy bank to protect against any losses from them -- possible the worst thing to have happen when a sovereign debt crisis erupts.

This isn’t new information, but too many North Americans know this. Nor do they understand that as the euro zone gets into more trouble, European banks are still happy to buy up government bonds from the region. In doing so, they only strengthen their ties to the sovereign crisis.

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